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Questor: our replacement for Lloyds offers scope for much faster rises in the dividend

An office in Frankfurt, Germany
Questor has chosen something different for readers: a property company focused on German business parks

Questor Income Portfolio:  it was the risk that divis would plateau that made us sell the bank. Our new stock, by contrast, has been increasing its divis rapidly

Last week, with some reluctance, we sold Lloyds Banking Group out of fear that it could not continue to raise its dividend for more than the next couple of years. We also promised to name its replacement in our Income Portfolio.

When choosing the new holding we had in mind the article that appeared here three weeks ago in which we discussed the idea that the best asset for income investors was property. Although we highlighted then the dangers of excessive property exposure we feel there is room in the portfolio for one more holding of this type.

Our focus is always on income sustainability, and long-term rental contracts confer a certainty in this respect that is hard to find in other types of business. And of course if one customer (tenant) goes bust or gets into some other kind of trouble, you, the property owner, still have your asset and can seek another tenant to replace the lost income.

Our portfolio already contains two property investment trusts, Standard Life Investments Property Income and Regional Reit, which between them offer exposure to a wide variety of real estate assets in Britain. So we will now add something a little different: a property company focused on German business parks.

This new stock is Sirius Real Estate (not, to be clear, Sirius Minerals, a far riskier stock that we recently advised readers to sell).

The firm, which listed in London in 2017, concentrates on buying properties with large amounts of unlet space and then using its in‑house marketing team and network of contacts to find the tenants previous owners might have struggled to.

Part of its approach is to make low-cost improvements to its properties to make them more attractive to potential tenants. In some cases it converts space to flexible working areas on the WeWork model or into self-storage. It has a wide variety of tenants, although it has been reducing its exposure to the car sector, which has been under pressure.

Its “active management” approach to property is something that Questor has been coming across more and more. Our sense is that it does indeed lead to better growth in asset values and income generation.

How does Sirius measure up against the two targets we set ourselves last week: to offer a yield similar to Lloyds’ but with better prospects of dividend growth?

We feel comfortable with Sirius on the latter score: as a much less mature business than a centuries-old British bank it has the scope to grow quickly. Certainly the dividend, denominated in euros, has increased appreciably in recent years – from 1.61 cents in 2015 to 2.22 cents the following year, then 2.92 cents in 2017, 3.16 cents last year and 3.36 cents this year – and we have every reason to expect more of the same. Certainly above-inflation rises in the divi should be possible and perhaps a good deal more.

What of the actual yield and the income we can expect in pounds and pence? Lloyds yields 5.5pc, based on last night’s closing price. But more relevant is the figure relative to our purchase price of 62p in December 2016, which is 5.2pc. Sirius yields 4pc.

We invested £20,000 in Lloyds, so we owned 32,259 shares. We sold at 57.2p, realising £18,452. Invested in Sirius that sum will give us 24,935 shares.

Based on the company’s full-year dividend for 2019, that means an income for our portfolio of £718 at the current exchange rate. Lloyds’ last full‑year payment was £1,036.

So we are accepting what we hope to be a short-term income shortfall of £318 a year in the expectation of significant rises in the dividend in the years ahead. If it maintains recent growth, Sirius should produce more income for the portfolio than Lloyds within the next few years.

In the long run, therefore, we think this change will benefit the Income Portfolio.

Questor says: buy

Ticker: SRE

Share price at close: 74p

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